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Guest blog: It's important to know your true business value

Posted by Taylor Rogers on April 16, 2014

(Editor’s Note: This is the fourth in a series of columns by family business leaders and advisors with information and ideas about topics unique to family businesses, developed in conjunction with the Conway Center for Family Business.) 

by Tim McDaniel
 
About the time I completed my 1,000th business valuation, I started to notice two disturbing trends within family businesses. The first was a major disconnect between the actual business value and the owner’s perception of that value. The second trend was that in most situations the business was the family’s largest financial investment, but it was not treated as an investment. The founders of the business were spending a considerable amount of time and money with their investment advisor growing their stock and bond portfolios, but putting no effort into knowing and growing the value of their largest asset, their business.
 
The major difference between your business investment and other investments (stocks, real estate and 401k) is that most business owners do not treat their business like an investment or have a plan to grow its value. Growth in the value of your family business will have a greater impact on your family’s financial future than the growth in any of your other investments.

There are major consequences of not knowing the actual value of your business, including:

  • Inability to retire when you want and with the lifestyle you expect
  • Choosing the wrong time to sell your business
  • Poor implementation and transfer of ownership to the next generation
  • Not understanding what drives your business value

Just as you receive quarterly and annual statements from your investment advisor so that you know the value of your stock portfolio, you should receive periodic reports on the value of your business. The best way of doing this is by having an annual business valuation prepared by a professional valuator.

With a well-prepared business valuation report, you will be able to track your family business investment performance over time and identify and understand the key drivers that impact the value of your business. As you learn what drives business value, you can make the necessary changes to your business that will increase its value. With periodic valuations, you can measure your progress and you will have no surprises when it comes time to retire or sell your business.

There are three major areas where you can focus in order to increase business value:

  • Increase your sustainable cash flow. Investors buy future cash flow, so any actions that increase the future cash flow of your business will increase its value. Investors love to buy cash flow that is sustainable and can grow in the future. 
  • Lower the risk associated with your business. A major factor in determining the price paid for a business is the rate of return required by the buyer. The more risky the investment, the higher rate of return needed to entice a buyer. There is an inverse relationship between value and the required rate of return. It is important that the business owner understand his or her risk areas and take steps to reduce them.
  • Increase the annual growth rate. The expected growth rate of the future cash flow levels will impact the value of a business. The higher the growth rate, the higher the value of the business. The owner can increase the value of the business by focusing on profitable and sustainable growth.

Stop guessing at the true value of your most important asset. Find out what it is really worth and treat it like the important asset that it is. With this mindset, your can change your family’s financial future.  

Tim McDaniel is the director of Rea & Associates, Inc. business valuation and succession plan­ning practice and a Conway Center for Family Business Service Provider member. He has been involved in over 2,000 valuation engagements during the 23 years. He prides himself on his ability to use plain English to teach business owners what the value of their company actually is and how they can meet their long-term succession goals.  In 2013, he released his first book, “Know and Grow the Value of Your Business: An Owner’s Guide to Retiring Rich.”

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